The EC is considering what is the appropriate prudential regime for investment firms. For many years, there has been the promise that the appropriateness of the prudential regime for investment firms would be reviewed and this has now started.  The EBA recognises that a prudential framework designed for banks should be simplified and adapted to the risks run by investment businesses.

EBA Proposals: Differentiation based on a firm’s activities and market profile

The proposed framework is based on a firm’s actual activities, its market presence and risk profile, and to achieve this, the EBA proposes differing regimes. Three tiers are recommended:

  • Tier 1 – Investment firms that are ‘bank like’ in structure and risk profile and are deemed systemic or otherwise present a clear risk to financial stability in normal conditions. For these firms there is unlikely to be any change.
  • Tier 2 – Non ‘bank-like’ investment firms that are of lesser systemic importance. For these investment firms a less complex prudential regime that is more tailored to the specific risks that investment firms pose to investors and to other market participants.
  • Tier 3 – Small and non-interconnected firms that warrant a very simple regime that has the objective of setting aside sufficient capital for an orderly wind-down.

In the UK, Tier 1 investment firms will typically be large investment banks that are currently subject to PRA prudential supervision. It is expected that Tier 2 will include firms that hold client assets and/or are part of a larger financial services group. Tier 3 firms would include independent advisors, arrangers and some investment managers.

The definitions and thresholds applied are subject to further discussion. These could be set centrally or by Member States provided ‘shopping around’ for a preferential prudential regime could be prevented.

What might the new prudential framework look like?

The paper contains a practical, comprehensive and thoughtful analysis of the key components of the current prudential framework. However, whilst a risk-focused framework is proposed, it may not reduce regulatory capital requirements. Key areas for further discussion include:

  • COREP/FINREP reporting: The EBA recommends that the current regime is replaced with one that is simpler and tailored. This could be more proportionate reporting, simpler templates or changes to the way firms have to submit returns.
  • ‘Going concern’ versus ‘gone concern’: The current framework was developed before this distinction was refined. For small firms, the emphasis is likely to be a ‘gone concern’ requirement based on a new wind down analysis. For others, this could replace recovery and resolution planning requirements and the recently introduced CRD IV capital buffers.
  • Client Money: The EBA has identified that the accounting for client money differs across the EU and raises questions about whether capital is required to be set aside to meet potential client money shortfalls. In addition, revised operational risk metrics for investment firms could be linked to client money (or assets) held.
  • Pillar 1: The EBA has also looked at rules that have caused specific technical difficulties for some investment firms such as the capital treatment of ‘qualifying holdings’ and investments in financial sector entities. There is also consideration of alternative Pillar 1 methodologies, which may be simpler for some firms.
  • Other topics: There are proposed exemptions/simplifications for Pillar 3 disclosures, remuneration codes and recovery and resolution planning requirements. Liquidity requirements are to be tidied up.
  • It should be noted that ICAAPs remain an important prudential supervisory tool. If the proposed regime is to achieve its objectives, we expect firms will need to continue to demonstrate that their ICAAPs are a realistic basis for setting more relevant internal capital requirements and Pillar 2 add-ons. It is also likely that regulators expect more emphasis on client asset management in ICAAPs.

Latest update

Back in 2016, the EBA published a discussion paper on designing a new prudential regime for investment firms.  The proposed framework focuses on the risks that firms pose to customers and to market integrity and liquidity. On that basis, the EBA proposes that ongoing capital requirements should be calculated based on capital factors (K-factors) that are attributed to one of these types of risks and then amplified by a measure of the risk to which firms themselves are exposed. The aim is that firms that pose more risk to customers and markets will get higher requirements than those who pose less risk, and firms that pose similar risk to customers and markets but with more own risk should hold more capital than those with less own risk.   Although the EBA’s preferred option is for the development of a new prudential regime, the EBA also considers the possibility of maintaining in some form the existing prudential treatment for investment firms set out in the Capital Requirements Regulation


Whilst there is a clear momentum to make these changes, the EC has not committed to an implementation timetable. Further work is needed to define the changes and amend the legislation. Our estimate is that the new prudential framework could be agreed late in 2017 and implemented from 2018 onwards.


This is hopefully the beginning of the end for the more disproportionate parts of CRD for many investment firms. For non-MiFID investment firms, the FCA may take the opportunity to align its own rules with the EBA’s new approach. It should simplify prudential compliance for the majority of investment firms and their supervisors and create a more level playing field. However, there is still a lot of analysis to be done and these proposals may not reduce capital requirements.

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